January 7, 2010

The FT's chief economics commentator, Martin Wolf, argues that, without the ability to manipulate national currencies, the EU's poorer members are going to have a very difficult time recovering from the global recession.

What would have happened during the financial crisis if the euro had not existed? The short answer is that there would have been currency crises among its members. The currencies of Greece, Ireland, Italy, Portugal and Spain would surely have fallen sharply against the old D-Mark. That is the outcome the creators of the eurozone wished to avoid. They have been successful. But, if the exchange rate cannot adjust, something else must instead. That "something else" is the economies of peripheral eurozone member countries. They are locked into competitive disinflation against Germany, the world's foremost exporter of very high-quality manufactures. I wish them luck.


Many have argued that, within a currency union, current account deficits do not matter any more than between Yorkshire and Lancashire. They are wrong. Deficit countries are net sellers of claims to the rest of the world. What happens if people in the rest of the world sell these claims or withdraw their loans? The answer is a recession. But within a country, people can move relatively easily to another region. That is usually far harder across borders. There is another, bigger, difference: the Spanish government cannot respond to the complaints of the Spanish unemployed by arguing that things are not so bad elsewhere in the eurozone. It must offer a national solution. The question is what.


Where does that leave peripheral countries today? In structural recession, is the answer. At some point, they have to slash fiscal deficits. Without monetary or exchange rate offsets, that seems sure to worsen the recession already caused by the collapse in their bubble-fuelled private spending. Worse, in the boom years, these countries lost competitiveness within the eurozone. That was also inherent in the system.

Coincidentally, Spain currently holds the EU's rotating presidency and it is issuing dire warnings about the need for greater cooperation.

The European Union single market and the euro may be damaged unless the bloc’s 27 countries do a better job of co-ordinating their recovery from the financial crisis and recession, the EU’s Spanish presidency warned on Thursday. “Without co-ordination of economic policies the single market and single currency could suffer heavily,“ Diego López Garrido, Spain’s EU affairs minister said. “The lesson from the crisis is that when we act separately we fail. When we act together, we get results,” he told reporters.

Mr López Garrido said one of Spain’s priorities would be to pass legislation establishing new EU-level financial supervision agencies to prevent a repeat of the 2007-08 turmoil in financial markets. Spain’s task will be to steer the legislation through the European parliament which wants to revise guidelines adopted by the 27 EU governments in December.

He said the fiscal crisis in Greece would test the EU’s political will to coordinate economic policy effectively. “But there are limits obviously. For example there is a rule in the Maastricht treaty called the no bail-out rule. Each country has a responsibility for its own budget because in Europe national budgets are big and the European budget is small.”

Mr López Garrido said it was necessary to remind financial markets that the crisis had erupted because of “the lack of regulation and the lack of rational behaviour in financial markets”

But, as Wolf observes, this was not only a natural byproduct of a centralized currency but one that was widely understood from the beginning.

The various states of the EU's predecessor, the European Community, were unable to coordinate their economic policies under the old Exchange Rate Mechanism which, like all cartels, created huge incentives for cheating.   During bad economic times, politicians in particularly weak economies naturally succumbed to temptations to adopt beggar-thy-neighbor policies.  And, when push came to shove, the countries with very strong economies -- most notably, Germany -- refused to put them at risk to save the others.

Moving to a unified currency under a central bank alleviated this problem but at the cost of taking away monetary policy from individual states.   That leaves, as Wolf notes, fiscal policy.  But recessions are hardly a time for raising taxes or slashing spending.

The weaker countries, then, have no good options.   And, not the least bit surprisingly, the relatively stronger economies -- among them, once again, Germany -- are in no mood to sacrifice the well-being of their own citizens to help out their neighbors.

James Joyner is managing editor of the Atlantic Council.